Chapter 17- Financially troubled companies:
BUSINESS RESCUE AND THE CORPORATE RESTRUCTURING OF FINANCIALLY
TROUBLED COMPANIES:
Look at hand out for case studies on One Time and Flexi-time [examinable]
Business rescue and corporate restructuring
“Financial need occurs when a company’s operating cash flows are not enough to
meet its current and future contractual obligations.”
Financial distress:
Companies Act 2008 (Section 128):
“1. It appears to be reasonably unlikely that the company will be able to pay off all of
its debts as they fall due and payable within the immediately ensuing six months, or
2. It appears to be reasonably likely that the company will become insolvent within
the immediately ensuing six months.”
Signs:
o Fall in share price
o Closing of plants and layoffs
o Change in management and director resignations
o Dividend cuts
o Decrease in research and development and capital expenditure
o Restructuring of operations
o Even companies with good prospects and valuable assets can be in financial
distress if debt cannot be refinanced or paid, and it can lead to bankruptcy
Actions to deal with financial distress:
1. Merge with another firm in the industry
2. Rights issue to current shareholders
3. Issue Preference or convertible securities
4. Suspend dividend payments
5. Compromise with creditors and banks and restructuring the terms of loans
6. Issue equity in exchange for debt
7. Sell non-core assets and divisions that do not perform
8. Sale and leaseback of assets
9. Liquidation or winding up of company
Issue of shares to public?
o Will be unlikely due to the fall in the share price which would result in the
dilution of the interests of the current shareholders.
Actions from the bank side:
o Loan covenants needs to be reset and re-scheduling of loans will become at a
cost.
o Re-pricing of loans will occur and interest rates will increase due to the
higher risk
o Firm may need to sell assets as a condition of providing finance
o Bank may require firm to undertake Hedging transactions such as forward
sales
o Banks facilitate the sale of equity and subordinated debt
Early indicators of financial distress:
, o Financial ratios e.g. interest cover; operating margins; debt to equity and cash
flow and also Altman’s Z Score
[Ignore these ratios for now – they will be given in the 4th term. Do not
have to know formulas. If calculation has to be made, formula will be
given].
Business rescue framework:
Results in temporary supervision and moratorium on creditors rights
As well as the development and implementation of a plan of restructure its affairs,
property, debt, other liabilities and equity
Which maximizes the chances that the company will continue in existence
If it cannot continue, then it should at least result in a better return for the creditors
than an immediate liquidation.
Company cannot meet its obligations:
Once a company has evaluated all of its options, it has three main options:
o Arrange a private workout with creditors
o Go into a business rescue procedure
Liquidation
o Place the firm into liquidation
Is Business Rescue a viable option?
No-one knows
However, there is evidence for Chapter 11 in the USA which is similar to business
rescue in RSA:
o The answer is that business rescues work mostly for larger firms
What is the alternative?
o The alternative is liquidation
Shareholders vs. creditors:
o Agency problem
Management and shareholders have different incentives
o Shareholders have an incentive to delay bankruptcy whilst secured creditors
would like to protect the value of the assets.
o The shareholders receive any appreciation of the assets whilst the creditors
share in any losses
o Creditors have the right to sell the assets of the company and determine when
it is optimal to do so
o When backs are against the wall, management and shareholders may decide to
increase the risk of their investments. This is not good for the creditors.
Priority rule in liquidations:
When a company goes into bankruptcy, there is an order of any distribution from the
proceeds of liquidation
1. Administrative fees due to liquidation
BUSINESS RESCUE AND THE CORPORATE RESTRUCTURING OF FINANCIALLY
TROUBLED COMPANIES:
Look at hand out for case studies on One Time and Flexi-time [examinable]
Business rescue and corporate restructuring
“Financial need occurs when a company’s operating cash flows are not enough to
meet its current and future contractual obligations.”
Financial distress:
Companies Act 2008 (Section 128):
“1. It appears to be reasonably unlikely that the company will be able to pay off all of
its debts as they fall due and payable within the immediately ensuing six months, or
2. It appears to be reasonably likely that the company will become insolvent within
the immediately ensuing six months.”
Signs:
o Fall in share price
o Closing of plants and layoffs
o Change in management and director resignations
o Dividend cuts
o Decrease in research and development and capital expenditure
o Restructuring of operations
o Even companies with good prospects and valuable assets can be in financial
distress if debt cannot be refinanced or paid, and it can lead to bankruptcy
Actions to deal with financial distress:
1. Merge with another firm in the industry
2. Rights issue to current shareholders
3. Issue Preference or convertible securities
4. Suspend dividend payments
5. Compromise with creditors and banks and restructuring the terms of loans
6. Issue equity in exchange for debt
7. Sell non-core assets and divisions that do not perform
8. Sale and leaseback of assets
9. Liquidation or winding up of company
Issue of shares to public?
o Will be unlikely due to the fall in the share price which would result in the
dilution of the interests of the current shareholders.
Actions from the bank side:
o Loan covenants needs to be reset and re-scheduling of loans will become at a
cost.
o Re-pricing of loans will occur and interest rates will increase due to the
higher risk
o Firm may need to sell assets as a condition of providing finance
o Bank may require firm to undertake Hedging transactions such as forward
sales
o Banks facilitate the sale of equity and subordinated debt
Early indicators of financial distress:
, o Financial ratios e.g. interest cover; operating margins; debt to equity and cash
flow and also Altman’s Z Score
[Ignore these ratios for now – they will be given in the 4th term. Do not
have to know formulas. If calculation has to be made, formula will be
given].
Business rescue framework:
Results in temporary supervision and moratorium on creditors rights
As well as the development and implementation of a plan of restructure its affairs,
property, debt, other liabilities and equity
Which maximizes the chances that the company will continue in existence
If it cannot continue, then it should at least result in a better return for the creditors
than an immediate liquidation.
Company cannot meet its obligations:
Once a company has evaluated all of its options, it has three main options:
o Arrange a private workout with creditors
o Go into a business rescue procedure
Liquidation
o Place the firm into liquidation
Is Business Rescue a viable option?
No-one knows
However, there is evidence for Chapter 11 in the USA which is similar to business
rescue in RSA:
o The answer is that business rescues work mostly for larger firms
What is the alternative?
o The alternative is liquidation
Shareholders vs. creditors:
o Agency problem
Management and shareholders have different incentives
o Shareholders have an incentive to delay bankruptcy whilst secured creditors
would like to protect the value of the assets.
o The shareholders receive any appreciation of the assets whilst the creditors
share in any losses
o Creditors have the right to sell the assets of the company and determine when
it is optimal to do so
o When backs are against the wall, management and shareholders may decide to
increase the risk of their investments. This is not good for the creditors.
Priority rule in liquidations:
When a company goes into bankruptcy, there is an order of any distribution from the
proceeds of liquidation
1. Administrative fees due to liquidation
